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Pound traders look past UK political turmoil

Have all the sterling traders gone to see the tennis at Wimbledon? A quick look at the currency’s performance over the past day or so would suggest they have.

The UK’s chancellor, Rishi Sunak, quit on Tuesday in a moment of high drama, judging that he could no longer participate in a government running out of public trust. A cascade of ministers followed suit.

So the political situation is, let’s say, fluid. But the pound is showing little reaction. While sterling has weakened this week, the move came ahead of the political news and was driven more by longer-running factors.

“Gone are the days when the sudden departure of a UK chancellor and an open split with the prime minister were big news in foreign exchange,” said Adam Cole, chief currency strategist at RBC Capital Markets.

If you cast your mind back six years, to the aftermath of the UK’s vote to leave the EU, sterling responded to almost every political twist and turn, at one stage earning the moniker of HM Government’s Unofficial Opposition. The currency showed that investors simply did not like Brexit, and the harder it looked like the break with the EU would be, the more it fell.

In 2022, heaven knows sterling has its issues. The dollar, always in favour in times of stress, is ripping higher as US interest rates are raised to tackle surging inflation, pushing the pound under $1.20 — a space it has very rarely occupied over the past 20 years.

But the Bank of England has already jacked up interest rates several times, and the pound has not picked up. Something else is clearly going on. Brexit true believers hate to hear it, but the economic impact of our messy divorce from the EU hurts, and the UK’s picking at the Northern Ireland protocol does not help. Some investors believe a larger decline could lie ahead for this reason.

Meanwhile, the short-term political drama is leaving little mark.

This is because markets, as a reflection of the wisdom of crowds, are a simple beast. They like nice clean stories. Boris Johnson himself has shown an ability to move the pound in the past. His declaration of support for Brexit in February 2016, when he was the popular mayor of London, sent the currency dropping by 2 per cent.

Line chart showing Odds of Boris Johnson ceasing to be Prime Minister in 2022 (%). Betting markets are virtually certain that Johnson will resign soon

Here, the story is not so clear. Cole at RBC pointed out that markets have already “all but written off Johnson as PM”. Bookmakers’ odds suggest the prime minister is not expected to last out the year. In addition, “there is no clear frontrunner to replace Johnson, so it is hard to take a view on what his departure would mean for policy”.

Zahawi may end up using lower taxes to bolster a populist agenda, maybe. That in turn might mean the Bank of England is more aggressive in raising interest rates, he said. On paper that is positive for sterling. But rate rises so far have done little if anything to prop up the pound, so that’s a lot of “maybes” to feed into a conviction trade.

“The new chancellor is not going to be in a position to substantially alter the course of the UK economy. This probably explains why sterling and other UK assets have barely moved on the news of these resignations and appointments,” said Paul O’Connor, head of the UK-based multi-asset team at Janus Henderson.

“The best he can hope for is to help steady the ship, until the global economic storm has passed. Some targeted fiscal measures seem more likely than an attempt at introducing a transformative new policy regime.”

Any sterling speculators looking for more substantial potential policy shifts to get their teeth in to may have to wait for a Scottish referendum on independence, or another general election.

Others are expecting a kick from the seemingly obvious denouement. “I can’t wait for the 1 per cent bounce in sterling when he [Johnson] finally gets dragged out,” as one hedge fund manager remarked.

katie.martin

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